The current structure of the federal bankruptcy courts dates back to the last complete overhaul of federal bankruptcy law in 1978. At that time, Congress created the bankruptcy courts pursuant to its authority under Article I of the Constitution to establish uniform laws on bankruptcy. But in Northern Pipeline Construction, the Court held that the exercise of federal judicial power could only be undertaken by judges appointed under Article III of the Constitution, noting that the exceptions to that rule were territorial courts, military tribunals, and cases involving “public” rights. Northern Pipeline involved a common law breach of contract dispute commenced by a company that happened to be in bankruptcy. Although it struck down the ability of a non-Article III bankruptcy court judge to make a final determination in an action that clearly pertained to a “private” state common law right, the Court strongly suggested that the system of Article I bankruptcy courts was itself permissible, stating that “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power,” in likelihood constituted the type of “public” rights which could be heard and decided by an Article I judge.

The question of what constitutes a “public” right has never been clear. Some earlier cases had suggested that the scope of a “public” right was fairly narrow, involving only rights between individuals and the government. Other cases suggested broader parameters. Although the Court in Northern Pipeline did not expressly state that “the restructuring of debtor-creditor relations” under federal bankruptcy law actually constituted a “public” right, Congress accepted the Court’s evident suggestion and in 1984 granted new jurisdictional authority to the United States Bankruptcy Courts. Under Section 157(b) of the Bankruptcy Act of 1984, bankruptcy court judges became authorized to render final decisions in “core” matters under the Bankruptcy Code. Section 157(c) directed bankruptcy court judges to hear and submit findings of fact and conclusions of law to Article III district court judges with respect to “non-core” matters.

Even though the Court never ruled on the constitutionality of the “core” and “non-core” bankruptcy jurisdictional construct, in other cases involving Article I tribunals the Court took an expansive view of the “public” rights doctrine, one that certainly appeared to be broad enough to encompass the list of “core” matters enumerated in the Bankruptcy Act of 1984. The separation of powers issues raised by Northern Pipeline appeared to have been laid to rest. Therefore, the Court’s ruling in Stern, that a matter could be a “core” matter under Section 157(b) but also not be a “public” right and thus not subject to final adjudication by an Article I bankruptcy court judge, was completely unexpected. Executive Benefits raised the possibility that the Court would go further by striking down the constitutionality of the “core” and “non-core” construct, and by strictly circumscribing the power of Article I bankruptcy judges.

The dispute in Executive Benefits involved a fraudulent transfer lawsuit. Although such an action is listed as a “core” matter under the Bankruptcy Act of 1984, the Ninth Circuit determined (and the Court assumed for purposes of the opinion) that it does not fit within the parameters of a “public” right under Stern and could not be adjudicated by a non-Article III judge. However, the Ninth Circuit also held that the bankruptcy court could prepare recommendations for review by the district court even though Section 157(b) of the Bankruptcy Act of 1984 does not explicitly authorize bankruptcy judges to submit proposed findings and conclusions in a “core” proceeding (as Section 157(c) does for “non-core” proceedings). It also held that the right to have a matter heard by an Article III judge was an individual right that could be waived, and that the defendant had implicitly consented to bankruptcy court jurisdiction.

Justice Thomas in Executive Benefits noted the “gap” created by what he referred to as “Stern” claims, i.e., matters listed as “core” under Section 157(b) but outside the scope of “public” rights. He also noted that, with respect to such Stern claims, the statute did not provide any direct authority for bankruptcy court judges to issue findings of fact and conclusions of law for review by an Article III district court judge. He had little difficulty, however, in finding that a severability provision in the statute (i.e., a provision that ensures the viability of the statute even if a portion of it is invalidated) “closes the so-called ‘gap’ created by Stern claims.” In other words, the Court avoided what could have been a huge logistical mess by stating that bankruptcy courts should simply deal with Stern claims under Section 157(c) as they would with “non-core” claims.

Moreover, because the dispute in Executive Benefits was subsequently reviewed by an Article III district court judge, the Court ruled that there was no need to address the separate constitutional question of whether the right to have a matter heard by an Article III judge was an individual right that could be waived.

Even a narrow ruling for the petitioner in Executive Benefits – that bankruptcy courts lack statutory authority to issue findings of fact and conclusions of law for review by an Article III district court judge with respect to “core” matters that fall beyond the scope of “public” rights that Article I judges may permissibly determine – could have wreaked havoc on the bankruptcy courts and placed huge burdens on district court judges. Such a ruling also would have raised questions about the wide-spread use of federal magistrates (who are also Article I judges) to hear and determine a wide array of criminal and civil matters. The result of Executive Benefits suggests strongly that the Court weighed the substantial disruptions which would result from extending Stern, and used Executive Benefits to walk it a few steps back.

The Court obviously left key questions unanswered. It did not address the scope of what constitute “public” rights, the extent to which they dovetail with the list of “core” matters set forth in Section 157(b) of the Bankruptcy Act of 1984, and whether the right to have a matter heard by an Article III judge is an individual right that can be waived. The Court’s ruling in Stern makes it inevitable that, at some point, each of these issues will need to be directly confronted.

Ben Feder is special counsel in Kelley Drye & Warren's New York office. He focuses his practice on bankruptcy and restructuring matters. Mr. Feder represents bank lenders, debtors, bondholders, creditors' More

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The firm represents creditors’ committees, debtors, financial institutions, indenture trustees, bondholders, landlords, suppliers and trading partners in out-of-court restructurings, bankruptcy reorganizations, and liquidations and related litigation. Our lawyers are at the forefront in working with clients to develop and execute strategies to maximize recovery, minimize exposure and realize the best business outcome.